Never make assumptions: Permanent establishment risks & the international assignee

In recent times, global tax reform has been moving at a lively pace, driven by several factors: the OECD’s Action Plan on Base Erosion and Profit Shifting (BEPS) initiative, local corporate tax reform initiatives, but just as importantly, the concept of permanent establishment (PE). Our Global Mobility Services Group experts explain the intricacies of PE and the situations that can give rise to a PE issue in their countries.

What is permanent establishment?

Permanent establishment or ‘PE’ is one of the fundamental principles used by local tax authorities to claim jurisdiction over a company doing business on their territory which is thus perceived to have created a taxable presence. It is a slightly grey area and misjudging how and where it applies can be a costly mistake. Recent tax reforms have empowered local tax authorities to investigate corporate structures and to re-categorize what some companies may dress up as auxiliary employee activities as direct sales employee activities that are therefore liable to local taxation.

To add to the uncertainty, what constitutes a permanent establishment under local tax rules will vary from country to country. In general however, PE is judged to exist if an activity carried out by a business in a country results in revenue being generated or value created.

How is PE determined?

Local tax authorities will carry out their own tests and then apply local PE laws and any relevant double tax treaties entered into by that country. These tests vary considerably, but the bullet points below show what are generally considered to be indicators of a PE in a country. A portion of the company’s income attributable to the PE (subject to certain exceptions) will be subject to local tax and social security contributions and subject to demanding reporting and filing requirements, registrations and professional fees.

For the assignee, cross border commuter or business traveler, income tax payments and social security contributions could be assessed.

* The OECD Model Tax Treaty defines a trigger for PE as being a “fixed place of business through which the business of an enterprise is wholly or partly carried on” in the host country. The terms are loosely defined and could include not only a formal office, but possibly the employee’s home office, an “office business center**” or in the case of protracted assembly work, containers on a construction site

* A specific individual (or a number of individuals) could create a PE risk, even when a true physical location of the employer does not exist 

* An employee’s job title (or description) shows that he/she carries out activities related to revenue generation or sales, and that employee works in the host country for an extended duration

* A company employee in the host country receives compensation such as commissions, bonuses and in some countries, even stock/share options that relate to sales activity

* Sales are to customers based in the host country and local contracts are negotiated by a locally-based employee or dependent agent. Although the employee or agent may not have the authority to close contracts, if he or she is deemed to be substantially involved in the negotiation of contract terms or the signing of such agreements, a PE may be deemed to exist.

** “Office business centers” or “executive suites”, provide physical office space and/or meeting rooms that can be available for use. It differs from a virtual office, which provides communication and address services for a fee, without providing dedicated office space.

Isabelle Paré, Senior Manager at Hardy Normand et Associés in Montreal adds:

“Even if the corporation does not have a PE, assignees/cross border commuters or business travelers remain liable to tax on employment income earned in the foreign country, subject to specific exclusions contained in tax treaties. In Canada for example, foreign companies with no PE can still be subject to tax and social security withholding requirements.”

You may also like to read...

• The Expat Post: Our newsletter for companies with international workforces and for individual expatriates (May 2017)

Examples of situations which could trigger a PE

* Your company transfers a high level executive (e.g. CFO) temporarily from global HQ to a different country to head up a new subsidiary with the CFO retaining some of his/her responsibilities in the home country. The host country’s tax authorities may consider that this individual’s activity creates a PE as the foreign company is actually conducting business in the host country (as the CFO is undertaking business related to the foreign country on the host country’s territory) and may therefore claim tax jurisdiction over both the local subsidiary and the foreign parent

* Your company sends a technical staff member to the host country to carry out a software installation and
provide maintenance services over an extended duration to a new client. Local tax authorities in the country may deem that the services rendered trigger a PE as revenue can be attributed back to these services

* An employee in the host country receives pay slips which include a job title comprising the word “sales.” PE may be automatically triggered due to the word “sales” being in the employee’s job title, whether that individual is
actually involved in the sales process or not 

* Your company hires a client relationship/account manager to work in the host country on the assumption that this position will not be linked to revenue generation and therefore will not trigger a PE. However, tax authorities may deem this type of activity to be a direct contributor to overall revenue generation.

Which situations can avoid a PE?

If the activity carried out by an individual is preparatory or auxiliary in nature, i.e. if it does not form an essential part of the business as a whole, a PE will generally not be deemed to exist. However, in practice, proving this can be difficult and is the responsibility of the company.

It is advisable to seek certainty from local tax authorities at the outset to ensure staff assignments are in compliance with local (tax) laws and structured as efficiently as possible from a tax perspective. In view of the varying definitions of what constitutes a PE and the definitions and exemptions held in tax treaties between countries, it is important to get good professional tax advice. Many of these issues can be resolved or mitigated through the correct planning and documentation.

Country experts give their views

Australia: Aaron Fitchett, Partner, Baumgartners

“The Australian Government taxes foreign residents on Australian sourced income. However, tax treaties override domestic law and limit the ability of the Government to tax a foreign company only to income derived in Australia through a PE. Tax treaty definitions of a PE vary from treaty to treaty, although they largely follow the OECD model, so it is critical to understand which activities create a PE in each case.

Employee and ‘agent’ activity in a host country needs to be closely scrutinised to understand whether a PE is created. The OECD is current focusing on artificial avoidance of PE status and is considering tightening up its definition of a PE to catch more employee / agent activities. Australia has strongly supported and implemented the OECD’s recommendations around BEPS and now has some of the strongest multinational anti-avoidance laws in the world.”

Canada: Isabelle Paré, Hardy Normand et Associés

“The fact that a non-resident is carrying on business in Canada does not necessarily mean that this will lead to tax liability and compliance requirements. The PE concept in Canada is based on the OECD Model Treaty and comments. However, new treaties tend to include a more service based concept, introducing rules to capture non-residents with significant presence through use of assignees or business travelers.

This approach is reflected in recent audits. The reduction of Canadian corporate tax rates, which are sometimes below the home country rate, may no longer be a net cost to non-resident companies, which make a PE issue less dramatic.”

Austria: Martin Seidl, Rothenbuchner und Partner 

“The Austrian PE concept follows the OECD Model Treaty and will be extended over time in line with BEPS. With respect to international assignees, PE risks only exist if the assignee acts on behalf of the foreign company in Austria; secondments to affiliated companies will not create a PE in Austria. As every assignment/secondment to Austria has to be notified to a local authority, any activity of a foreign company in Austria for an extended duration should be checked by a tax advisor to avoid any PE risk.”

UK: David Gibbs, Alliotts

“The circumstances which give rise to a PE in the UK are broadening in line with the OECD’s proposals which seek to identify where economic benefit is really being obtained (the “nexus” approach). As a result, understanding the breadth and depth of the activities of overseas employees in the UK has become a more important subject for HMRC.

HMRC wants to know exactly who enters the UK to work even if it is for only a short period. As an inducement to reporting the movements of overseas employees in the UK, HMRC introduced the Short-term Business Visitors Agreement for companies which requires them to report employees entering and leaving the UK, but then removes the payroll burden where the employee is exempt from tax through a double tax treaty.”